In dairy consolidation, lush paydays

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Kevin Cornett mixes milk at Sweetwater Valley Farms in Philadelphia, Tenn. Consolidation in the dairy industry, as led by Dean Foods and its chief executive, Gregg Engles, has brought huge paychecks to a small group of people. - Bulletin

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Kevin Cornett mixes milk at Sweetwater Valley Farms in Philadelphia, Tenn. Consolidation in the dairy industry, as led by Dean Foods and its chief executive, Gregg Engles, has brought huge paychecks to a small group of people.1816186

There was a time not long ago when Gregg Engles was considered a genius in the dairy industry, a shrewd CEO who had cobbled together a string of local businesses to create the nation’s largest milk bottler, Dean Foods.

Dean’s website described Engles as the primary architect of dairy consolidation, the often painful and perhaps inevitable shift to fewer, larger farms and bottling plants. His company’s soaring share price made him a Wall Street star.

In fawning profiles in the business press, dairy cliches flew: Engles was “cream of the crop,” “head of the herd” and “milkman to the nation.”

These days, however, as he prepares to step aside as chief executive of Dean Foods, Engles, 55, is perhaps better known for his paychecks, which continued to be hugely generous even as his company’s fortunes tumbled.

The Motley Fool noted in March that he had averaged $20.4 million in compensation over the previous six years, while Dean’s stock fell 11 percent a year, on average. Forbes ranked him among its Worst Bosses for the Buck in 2011.

Wall Street soured on the nation’s milkman.

A long-running antitrust lawsuit in a federal courthouse in Greeneville, Tenn., offered one possible explanation for his early success, by contending he engaged in a conspiracy more than a decade ago that helped expedite dairy industry consolidation and make himself a bundle.

Filed by a group of dairy farmers in 2007, the lawsuit said Engles cut a deal with the head of the nation’s largest dairy cooperative, the Dairy Farmers of America, to eliminate competition in the Southeast. Another lawsuit was filed in Vermont in 2009, involving allegations of a similar scheme in the Northeast. Dean Foods, whose brands include Garelick Farms, Land O Lakes and Horizon Organic, has settled both lawsuits, without admitting wrongdoing; the suits continue against the DFA.

By normal rhythms of the industry, Engles and Gary Hanman, 78, a former chief executive of the DFA, would be financial adversaries. That’s because bottlers try to buy raw milk as cheaply as possible. Many farmers joined cooperatives in the hope they could leverage their numbers for higher prices.

But according to the lawsuit, the deal that Engles made with Hanman went against normal economics. Engles promised that the DFA would be the exclusive supplier to Dean’s milk plants. The DFA, in turn, promised a reliable supply of Dean’s main ingredient, raw milk, at the lowest prices, plus rebates and credits so Dean could acquire more milk plants, the suit says.

It all resulted in a small group of men making enormous sums of money, according to files in the Southeast lawsuit that recently became public. One business partner of Hanman was paid $100 million by Dean’s predecessor and the DFA for his stake in milk plants; the partner had paid $6.9 million for it two years earlier. A business partner of Engles was paid more than $80 million for his investment in milk plants; that partner had paid little more than $5 million.

Hanman was paid $31.6 million during his seven-year tenure as chief executive, including bonuses for increasing the cooperative’s market share, according to court records.

As for Engles, his compensation over the last decade comes to $156 million, according to Equilar, a firm that tracks executive pay.

Dairy farmers say they didn’t share in the riches. Instead, they say that they were paid suppressed prices for raw milk, and that the fallout continues. They are seeking more than $1 billion, including penalties, in the Southeast; the damage estimate for Northeast farmers remains under seal.

Dr. Sam Galphin, a North Carolina dairy farmer and veterinarian, said the Dean-DFA pact was devastating to dairy farmers in the Southeast, cutting into incomes and ultimately forcing some out of the business. He said he continues to get suppressed prices for raw milk because there are few if any options for farmers, and he expects to lose $100,000 on his dairy farm this year.

“Even today there is no competition in this market,” he said. “Half of the people who were in business when the lawsuit was filed are now out of business.”

Through a Dean spokeswoman, Engles declined to comment for this article. Dean settled the suit with the Southeast farmers for $140 million in July, and settled with the Northeast farmers a year earlier, for $30 million. In both cases, it admitted no wrongdoing.

“We continue to be confident that we operated appropriately in our raw milk procurement,” a Dean Foods statement said. “We settled these cases to avoid the expense, uncertainty and distraction of litigation and the possibility of a lengthy appeals process.”

Engles is stepping down as CEO in coming weeks, though he will remain chairman. On Friday, Dean had an initial public offering of its WhiteWave-Alpro unit, which includes the Silk and Horizon Organic brands; Engles will be CEO of the new company.

Hanman referred questions to his lawyer, who declined to comment. A trial in the Southeast case against the DFA is scheduled to begin in January; the Northeast case against the cooperative has not reached a trial stage.

Richard Smith, the DFA’s current president and chief executive, disputed the notion that the pact between Dean and the DFA was a conspiracy that suppressed prices for farmers. Instead, he characterized it as a business decision that didn’t always work out the way the cooperative had hoped.

He maintained that the DFA was able to charge Dean and other processors higher prices in the Southeast, but that this was often offset by the costs of bringing in additional milk from elsewhere to meet bottlers’ demands.

But Smith, who succeeded Hanman in 2006, said the DFA had been “hung up on big rather than best.”

As for the payments to its former business partners, he said: “The premise of a lot of these partnerships was DFA would bring the milk and largely the investments and the partners would bring the expertise and know-how. And if all things worked out, it would be a win-win.

“Obviously when you look at some of the facts, some of it looks skewed, there is no doubt.”

The Justice Department conducted a 26-month antitrust investigation into the dairy industry during President George W. Bush’s second term and recommended that enforcement action be taken against Dean Foods and the DFA, but no charges were filed, according to state and federal officials.

Destiny in dairy

Gregg Engles stumbled into the dairy business, though he seemed destined to consolidate something.

According to several published profiles, he was born in Durant, Okla., and raised primarily in Denver. His father was a doctor.

His early résumé is impressive: Dartmouth College, Yale Law School, law clerk for Anthony M. Kennedy, who was then a judge on the U.S. Court of Appeals. Engles was admitted to the bar in Colorado and Texas.

But working for a law firm didn’t interest him. Young lawyers he knew were making money but seemed bored with their jobs. By contrast, several entrepreneurs “impressed him as being fully engaged in their work,” according to a 2002 article in Chief Legal Officer, a publication that is now defunct.

After unsuccessful ventures, Engles and a partner paid $22 million, most of it borrowed, for Reddy Ice, a packaged-ice company. Engles then set about consolidating the packaged-ice business, tripling his company’s size in seven years through acquisitions, according to a Forbes article in 2000.

During a golf game, Cletes Beshears, who was known as Tex and had run the dairy business of the Southland Corporation, then the parent of 7-Eleven, suggested that Engles could do the same in the dairy business.

“By the time we had made the turn,” Engles told The Dallas Morning News in 1999, “Tex and I had become partners in the dairy business.”

Their first in a series of acquisitions was a $100 million leveraged buyout of Suiza Dairy in Puerto Rico. Suiza went public in 1996 and, four years later, after 40 acquisitions, was the nation’s biggest dairy processor. But Engles wasn’t finished. He set his sights on his biggest rival, Dean Foods.

If Engles stumbled into the milk business, his ally in the Dean acquisition, Hanman, seemed destined to run a dairy cooperative.

He grew up on a livestock farm in north central Missouri, married his high school sweetheart and earned a bachelor’s degree in agricultural economics from the University of Missouri, according to the Cooperative Hall of Fame. He also earned a master’s in dairy marketing.

After a lengthy stint in the milk marketing office of the Agriculture Department, he began working for dairy cooperatives in 1964. Described as whip-smart and politically savvy, with a folksy demeanor that made him popular with farmers — he wore bright red suspenders with “Dairy Farmers of America” down the front — he rose quickly through the ranks.

But the ascent wasn’t without controversy. He was questioned, but not charged, in an investigation into accusations that the Nixon administration bolstered milk price supports after the dairy industry pledged $2 million in campaign contributions. In 1988, he was suspended from trading for two months on the National Cheese Exchange in Wisconsin for bragging to members about boosting the price of cheese. And in 2008, the DFA, Hanman and a colleague paid a $12 million fine to settle charges that they had tried to manipulate milk futures.

Like Engles, Hanman was a proponent of consolidation. The DFA was created in 1998 through the merger of four smaller cooperatives, one of which was overseen by Hanman.

And, like Engles, Hanman went against the time-honored practices of his trade. For instance, instead of squabbling with bottling companies over price, he sought joint ventures with them. Such arrangements gave members “greater market security and an opportunity to capture income from the retail market,” he was quoted as saying in a 2000 academic article published in the International Food and Agribusiness Management Review.

One joint venture was Suiza Foods. The DFA owned a third of Suiza’s dairy division and provided Suiza’s plants with raw milk.

“The Suiza relationship reflects a major strategy change compared to the traditional role of a full-service milk cooperative,” the academic paper said.

The lawsuits take another view, contending that it was the beginning of a relationship that ultimately increased the power — and paychecks — of a small group of executives at the expense of unwitting dairy farmers.

Milk mergers

“I enjoyed our meeting on Friday, and came away more convinced than ever that we share common interests in the evolution of the dairy industry, and that we can do an enormous amount of business together,” Engles wrote in a 1997 letter to Hanman that is part of the court file.

As part of Suiza’s deal with Hanman, Engles agreed to provide exclusive supply agreements to the DFA. The deal gave the cooperative an outlet for its farmers’ milk, but also forced farmers to sign up with the cooperative if they wanted to continue selling to Suiza plants. The cooperative, in turn, agreed to use credits and rebates to help Suiza expand, and it turned over its share of milk bottling plants to Suiza.

Such deals worked out very well for the cooperative’s partners in the milk plants. For instance, Pete Schenkel, a business associate of Hanman, was paid $100 million in 2000 for his share of Southern Foods, a dairy processor, by the cooperative and Suiza.

Allen Meyer, Schenkel’s partner at Southern Foods, turned a $70 million profit on one bottling venture with the cooperative, and Robert Allen, a veteran dairy executive, made $22 million on his two-year investment in bottling plants with the cooperative.

On their investments in bottling plants with the DFA, Beshears made more than $80 million and Tracy Noll, who had worked with him in the dairy side of the Southland Corporation, made more than $26 million, court records show.

As Engles claimed a greater and greater portion of the dairy processing industry, he told The Dallas Morning News in 1999 that he hoped to achieve a market share of 30 percent to 40 percent in three or four years.

In fact, it took him just two years. He worked out the deal to buy Dean Foods on a hunting trip in South Dakota with Hanman and Schenkel, among others, court records show.

The merged entity kept the Dean Foods name and worked out an arrangement with DFA that expanded their relationship and their control over dairy farming and milk processing, particularly in the nation’s eastern third.

To appease Justice Department concerns, Suiza and Dean sold some of their dairy plants to a newly created company, National Dairy Holdings, that was supposed to provide additional marketplace competition.

But the DFA provided much of the funding for National Dairy Holdings, and the new company’s partners were Beshears, Meyer and Noll. Hanman served on National Dairy Holdings’ management committee and had veto power over its decisions. As was the case with Dean Foods, the DFA was given full-supply agreements with National Dairy Holdings.

In other words, National Dairy Holdings wasn’t a real competitor but a thinly veiled arm of the DFA, court records show. Meyer, the CEO, later testified that he didn’t set prices for his milk without checking with the DFA to find out what Dean and other processors were charging first.

Though dairy farmers and other cooperatives did not have to join the big cooperative, they were required to sell their milk through new marketing agencies controlled by the DFA if they wanted to sell milk to Dean or National Dairy Holdings.

A provision in the DFA’s contract with Dean required the cooperative to sell raw milk at the lowest price in the marketplace, court records show.

But the cooperative’s control of the Southeast created a problem: There weren’t enough farmers to meet demands of milk plants in the region. So it required farmers to pay the costs of having milk trucked in from the Southwest, where a proliferation of huge dairies produces a surplus of milk.

As it turned out, the DFA had its own milk hauling company, which it owned with a Missouri man named William Honeycutt, who owned a hunting lodge in South Dakota with Hanman and others. The cooperative eventually bought Honeycutt’s $247,500 stake in the company for $18.1 million, court records show.

Noll, Beshears and Meyer could not be located for comment. Schenkel declined to comment.

Honeycutt didn’t dispute his earnings from the hauling company. But he said he and the cooperative each put $247,500 into the transport company to begin with and built it into a $32 million operation, when he sold his half.